Market Recap

Charles Dickens opened his famous novel A Tale of Two Cities with an even more famous line: “It was the best of times, it was the worst of times.” Dickens is proving to be quite the prophet: The past six months could very well have been the worst of times. The goods new is, the times, if not the best, are surely getting better.

At least that might finally be the case for homebuilders, because housing starts unexpectedly surged in February. Work began on an annual rate of 583,000 homes, a 22% increase from January, posting the biggest jump since 1990. The rebound suggests builders cut production too deeply as the credit crunch intensified at the end of 2008, and they may have to make up for some lost time.

Of course, any sustained recovery in the homebuilding market will be contingent on a recovery in the financial markets. The good news here is that a recovery in the financial markets appears to be under way. Stocks continued to rally last week, though not as much as credit markets. Indeed, 30-year fixed-rate home loans slid by as much as 3/8 of a percentage point to around 5%, nearing record lows. Until recently, 30-year fixed-rate mortgages hadn't been below 5% since the 1950s.

The latest rally in mortgage rates was spurred by the Federal Reserve's ongoing efforts to stimulate borrowing. In its latest go-around, the Fed said it would add $750 billion to the till to raise its total purchases of Fannie Mae, Freddie Mac, and Ginnie Mae mortgage bonds to $1.25 trillion by year's end. The Fed also said it will double its potential note purchases from Fannie, Freddie, and the Federal Home Loan Bank System to $200 billion and absorb as much as $300 billion in Treasury securities, which will add at least as much liquidity to the economy.

But Will They Go Lower?

Many analysts believe that last week's Federal Reserve action to lower interest rates virtually assures a low-rate mortgage environment through 2009. We're not so sure. All this liquidity the Fed is pumping into the system will eventually stimulate some form of inflation – defined as too much money chasing too few goods. In fact, we might be seeing the early rumblings of inflation already. The consumer price index rose 0.4% in February after climbing 0.3% the previous month. The consensus estimate was for a 0.3% increase.

Prognosticating is a difficult endeavor, to be sure, especially when it's about the future. We know that higher inflation equals higher interest rates. Whether we get higher rates next week, next month, or next year is anyone's guess. And could rates continue to slide lower? Sure, but what are the odds they will slide significantly lower? We don't think overly great. After all, mortgage rates can start to tick back up if too many lenders feel they don't have to compete on price or if they lack the sources for funding their loans.

We still think now is a good time to refinance a loan or buy a house, especially for borrowers whose best option is a FHA loan. Starting April 1, the loan-to-value ratio of any cash-out refinance insured by the FHA can no longer exceed 85% of the appraiser's estimate of value. The new limit is temporary, although the FHA says it will continue to analyze the housing and mortgage markets as well as its own portfolio to determine whether the changes should be made permanent.

But why chance not getting a higher cash out or why chance getting caught in an inflation up-draft when rates are currently so low? We think today is the best of times for many borrowers and potential homeowners.